Bull Put Spread
Introduction
You have been researching a stock and have formed a bullish opinion on its value, forecasting that it will rise in price over the coming months. You would like to limit your risk while collecting a premium to establish this position.
Building on your foundational knowledge of call and put options as well as the risks and benefits of single-leg options trades (buy call, sell call, buy put, sell put), you recognize that a two-leg trade, or spread trade, achieves the objectives you have outlined.
Specifically, selling a put expresses your bullish sentiment and achieves the goal of collecting options premiums. By purchasing a lower strike put, you further limit the downside risk introduced by the short put.
The combination of a long put and short put is referred to as a spread trade. Risks and benefits of each individual option component, or leg, offset each other to a degree to create the desired position and range of possible outcomes.
What is a Bull Put Spread?
A bull put spread consists of one short put with a higher strike price and one long put with a lower strike price:
- Long 1 XYZ 95 put
- Short 1 XYZ 100 put
Both puts have the same underlying stock and the same expiration date.
A bull put spread is established for a net credit(or net amount received) and profits from a rising stock price and/or from time decay.
Both maximum profit and maximum risk (loss) are limited and known.
Worth noting: The “bull put spread” strategy may also be referred to as a “credit put spread” and as a “short put spread.” The term “bull” refers to the fact that the strategy profits with bullish, or rising, stock prices. The term “credit” refers to the fact that the strategy is created for a net credit, or net amount received. Finally, the term “short” refers to the fact that this strategy involves the net selling of options, which is another way of saying that it is established for a net credit.
Example
- Long 1 XYZ 95 put for $1.30
- Short 1 XYZ 100 put at $3.20
In our example, assume stock XYZ is currently trading around $101.
We buy 1 XYZ 95 put for a total of $130 (1 x 100 multiplier x $1.30) and sell 1 XYZ 100 put for a total of $320 (1 x 100 multiplier x $3.20).
In this example the bull put spread (long put + short put) positions were established for a net credit of $190 ($320 - $130 = $190).
Outcome 1: Profit
With a bull put spread position, potential profit is limited because of the short put.
First, let’s recall the formulas for individual options positions:
Put Options:
- If K – S > 0,
Long Put Profit = Strike Price - Current Stock Price - Net Premium Paid
Short Put Loss = -(Strike Price - Current Stock Price - Net Premium Received)
- If K – S < 0,
Short Put Profit = Net Premium Received
Long Put Loss = Net Premium Paid
To calculate our profit on the position we established, we use the formula:
Profit = Profit/Loss on Long Put + Profit/Loss on Short Put
The maximum profit of the bull put spread is limited to the net premium received less commissions and fees. The maximum profit is realized if the stock price is at or above the strike price of the short put (higher strike).
Example
Stock XYZ is trading at $101 and you establish a bull put spread for a $1.90 credit.
- Long 1 XYZ 95 put for $1.30
- Short 1 XYZ 100 put at $3.20
A week later, stock XYZ is trading at $110.
*Unrealized profits are those that potentially exist; realized profits/loss occur when you close out or trade out of the position.
Outcome 2: Loss
Let’s assume we are incorrect in our sentiment, and the stock price declines. To calculate our loss on the position, use the following formula:
Loss = Profit/Loss Long Put + Profit/Loss Short Put
Remember, the stock price cannot trade below $0. Maximum loss is equal to the difference in the strikes less the net premium received. Our maximum loss for the bull put spread is limited because the gains from the long put position offset the short put position losses when the stock price is below the strike price of the long put (lower strike).
In our example:
Max Loss = High Strike – Low Strike – Net Premium Received
= $100 – $95 – $1.90
= $3.10 per share or $310 total loss (not including transaction costs and fees)
Example
Stock XYZ experiences unexpected news and is now trading lower at $93.
*Unrealized profits are those that potentially exist; realized profits/losses occur when you close out or trade out of the position.
Outcome 3: Breakeven
The breakeven price calculated on a per share basis for a bull put spread is equal to the short put strike minus the net premium received.
Breakeven Price = Short Put Strike – Net Premium Received
Example
- Long 1 XYZ 95 put for $1.30
- Short 1 XYZ 100 put at $3.20
Breakeven Price = $100 – $1.90 = $98.10
At-A-Glance
Strategy
Bull Put Spread
Alternative Name
Credit Put Spread
Pre-Requisite Strategy Knowledge
Long Put
Short Put
Legs of Trade
2 legs
Sentiment
Bullish
Example
· Long 1 XYZ 95 put
· Short 1 XYZ 100 put
Rule to Remember
Long put strike must be lower than the short put strike, expirations must be the same
Max Potential Profit (GAIN)
Limited: Net Premium Received
Break-Even Point
Short Put Strike – Net Premium Received
Max Potential Risk (LOSS)
Limited: Higher Put Strike – Lower Put Strike – Net Premium Received
Ideal Outcome
XYZ price increases to or above the higher put strike
Margin Requirement
Yes
Early Assignment Risk
Early assignment risk applies to short options positions only.
Equity options in the United States can be exercised on any business day, and the holder of a short stock options position has no control over when they will be required to fulfill the obligation. Therefore, the risk of early assignment must be considered when entering positions involving short options. Early assignment of stock options is generally related to dividends.
The long put (lower strike) in a bull put spread has no risk of early assignment.
The short put (higher strike) does have such risk.
If the stock price is below the strike price of the short put in a bull put spread (the higher strike), an assessment must be made if early assignment is likely. If assignment is deemed likely and if a long stock position is not wanted, then appropriate action must be taken.
Before assignment occurs, the risk of assignment can be eliminated in two ways:
- First, the entire spread can be closed by buying the short put to close and selling the long put to close.
- Alternatively, the short put can be purchased to close and the long put can be kept open.
If early assignment of a short put does occur, stock is purchased. If a long stock position is not wanted, the stock can be sold either by selling it in the marketplace or by exercising the long put.
Note, however, that whichever method is chosen, the date of the stock sale will be one day later than the date of the stock purchase. This difference will result in additional fees, including interest charges and commissions. Assignment of a short put might also trigger a margin call if there is not sufficient account equity to support the stock position.
Potential Position Created at Expiration
There are three possible outcomes at expiration: the stock price can be at or above the higher strike price, below the higher strike price but not below the lower strike price, or below the lower strike price.
- If the stock price is at or above the higher strike price, then both puts in a bull put spread expire worthless and no stock position is created.
- If the stock price is below the higher strike price but not below the lower strike price, then the short put is assigned and a long stock position is created.
- If the stock price is below the lower strike price, then the short put is assigned and the long put is exercised. The stock is then purchased at the higher strike price and sold at the lower strike price, resulting in no stock position.
Charts
